Inverted Hammer Candlestick

The inverted hammer is similar to the hammer in that it occurs after a downtrend and is a bottom reversal pattern. The inverted hammer has a small real body, either bullish or bearish, and has a large upper shadow with a small or no lower shadow. Most importantly, a trader should wait until the following trading session for confirmation. Signs of confirmation of the inverted hammer candlestick are: the next trading session gaps up or the next day is a strong bullish candlestick.

Psychology of Inverted Hammer

An explanation of why it is important to wait for confirmation of higher prices after an inverted hammer is explained with market psychology. Often the opening and closing of a session of trading has the highest volume. When bears go short at the opening and closing times of the session and the next trading session gaps up and moves higher, these shorts are now in a losing position. The higher the prices of the trading session after the inverted hammer go, the more the shorts lose money and the more likely they will buy to cover their shorts, this adds to the buying pressure pushing prices even higher.

Inverted Hammer Candlestick Chart Example

The chart above of the S&P Mid-Cap 400 ETF (MDY) illustrates a bottom reversal off of an inverted hammer candlestick pattern. The pattern is preceded by a multi-week downtrend. The day prior to the inverted hammer is a bearish candlestick. The inverted hammer candlestick opens lower, but then bulls are immediately able to push prices higher. However, the bears completely reject the bullish gains and the price closes where it began for the day. It is important to note that even though the inverted hammer candlestick is on the chart, at this point the inverted hammer pattern is not complete. The following day should confirm higher, which it does. The day after the inverted hammer candlestick, prices gap significantly higher and move higher for the rest of the day, creating a large bullish candle. Those traders who went short the day of the inverted hammer are all in losing trades. The trend reversed off the inverted hammer pattern and prices enjoyed a multi-week price uptrend.